Italy and France stir debt crisis fears again

Financial markets are becoming increasingly concerned about the risk of a fresh outbreak of the euro zone debt crisis, triggered by political instability in Italy and the inability of France’s socialist government to find a solution to the country’s woes.

Fitch Ratings downgraded Italy’s credit ratings last Friday by a notch to “BBB+" due to concerns about the country’s deepening recession and political instability. It said the inconclusive results of the recent Italian elections made it unlikely that a stable new government could be formed in the next few weeks.

Fears are growing that Italian political instability will derail the country’s reform program begun by outgoing technocrat leader
Mario Monti
. German Finance Minister Wolfgang Schäuble has also weighed into the debate, urging Italian political leaders to continue with Monti’s reforms.

“Italy has steadily improved its competitiveness with the structural reforms of the past 1 ½ years, it has improved its financial position and won the trust of the markets," he said in an interview with the Austrian daily Der Standard published on Saturday.

“It would therefore be wrong to change the path now. There is a politically complicated situation in Italy now, we know that, but the Italians will have the strength to form a government out of this."

Schäuble and his boss, German Chancellor
Angela Merkel
, have been extremely careful about commenting on the Italian election, which was widely seen as a stinging rejection of German-backed austerity. But last week, the head of Merkel’s junior coalition partner, Rainer Brüderle, warned that Italy would have to accept the consequences if it chose not to adjust to the common currency. “That could mean that they exit [the euro] or that they take drastic measures," he said on a German talk show.

Meanwhile, support for French President François Hollande is likely to slip further after the French government said it would cut spending by an extra €5 billion ($US6.5 billion) in 2014. The additional belt-tightening became necessary after Paris admitted last month that it would not meet its target of cutting its deficit to below 3 per cent of GDP this year. Brussels has agreed to give France extra time to meet its budget target, provided the Hollande government introduces structural reforms and redoubles its deficit-cutting efforts in 2014.

But the extra spending cuts will deal a further blow to France’s listless economy. In the final three months of 2012, the economy contracted 0.3 per cent, while the jobless rate climbed to 10.6 per cent, the highest level since 1999. Young people have been hardest hit, with more than a quarter of 15- to 24-year-olds now unemployed.

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Support for Hollande, who won the French presidential election last May promising pro-growth policies, is also wilting. According to opinion polls, two-thirds of French voters are now disappointed with Hollande and disapprove of his social and economic policies.

Perhaps inspired by Hollande’s woes, former French president
Nicolas Sarkozy
has hinted that he may be forced to return to politics to save France. “I have no desire to return to the world of politics, which I find a deadly headache," he told the conservative French weekly Valeurs Actuelles. But, he added “unfortunately, there will be a moment when it won’t even be a question of ‘Do you want to?’ but ‘Do you have a choice?’ " If France became torn between the extreme left and the extreme right, he said, “I would be obliged to return. Not out of desire. Out of duty. Only because it is a question of France."

Sarkozy also lashed out at Hollande’s opposition to German-backed austerity, saying he had “broken everything that I succeeded in building with Angela Merkel."

But International Monetary Fund boss
Christine Lagarde
has called for northern European countries such as Germany to make stronger efforts to boost demand – which would mean allowing higher inflation and wage growth – to offset the effects of austerity policies in southern Europe.

In a speech in Dublin on Friday, Lagarde also called on the European Central Bank to cut its key interest rate further, saying she expected the region’s economy to remain in recession this year.